UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

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FORM 10-Q

 

 

For the quarterly period ended March 31, 2014

 

OR

 

 

For the transition period from                      to                      

 

Commission File Number: 000-51556

 

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GUARANTY BANCORP

(Exact name of registrant as specified in its charter)

 

 

303-675-1194

(Registrant’s telephone number, including area code)

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Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934, during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x No ¨ 

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes  xNo ¨ 

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. 

Large Accelerated Filer  ¨  Accelerated Filer   x 

Non-accelerated Filer  ¨  (Do not check if smaller reporting company) Smaller Reporting Company ¨

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act): Yes ¨ No x 

 

As of April 28, 2014, there were 21,696,107 shares of the registrant’s common stock outstanding, consisting of 20,677,107 shares of voting common stock, of which 745,406 shares were in the form of unvested stock awards, and  1,019,000 shares of the registrant’s non-voting common stock.

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Table of Contents

 

 

 

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PART I – FINANCIAL INFORMATION

 

Item 1. Unaudited Condensed Consolidated Financial Statements

 

GUARANTY BANCORP AND SUBSIDIARIES

Unaudited Condensed Consolidated Balance Sheets

 

 

 

See "Notes to Unaudited Condensed Consolidated Financial Statements."

 

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GUARANTY BANCORP AND SUBSIDIARIES

Unaudited Condensed Consolidated Statements of Income

 

 

 

See "Notes to Unaudited Condensed Consolidated Financial Statements."

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GUARANTY BANCORP AND SUBSIDIARIES

Unaudited Condensed Consolidated Statements of Comprehensive Income

 

 

 

 

 

 

 

 

See "Notes to Unaudited Condensed Consolidated Financial Statements”

 

 

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GUARANTY BANCORP AND SUBSIDIARIES

Unaudited Condensed Consolidated Statements of Changes in Stockholders’ Equity

 

 

 

 

 

 

 

 

 

 

 

 

See "Notes to Unaudited Condensed Consolidated Financial Statements."

 

 

 

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GUARANTY BANCORP AND SUBSIDIARIES

Unaudited Condensed Consolidated Statements of Cash Flows

 

 

 

 

 

See "Notes to Unaudited Condensed Consolidated Financial Statements."

 

 

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(1)Organization, Operations and Basis of Presentation

 

Guaranty Bancorp is a bank holding company registered under the Bank Holding Company Act of 1956, as amended, and headquartered in Colorado.

 

The Company’s principal business is to serve as a holding company for its bank subsidiary, Guaranty Bank and Trust Company, referred to as the “Bank”.

 

References to “Company,” “us,” “we,” and “our” refer to Guaranty Bancorp on a consolidated basis. References to “Guaranty Bancorp” or to the “holding company” refer to the parent company on a stand-alone basis. References to the “Bank” refer to Guaranty Bank and Trust Company, the Company’s wholly owned bank subsidiary.

 

The Bank is a full-service community bank offering an array of banking products and services to the communities it serves along the Front Range of Colorado, including accepting time and demand deposits and originating commercial loans (including energy loans), real estate loans (including jumbo mortgages), Small Business Administration (“SBA”) guaranteed loans and consumer loans. The Bank and its wholly owned subsidiary, Private Capital Management, LLC (“PCM”) provide wealth management services, including private banking, investment management and trust services. Substantially all of the Bank’s loans are secured by specific items of collateral, including business assets, commercial and residential real estate, which include land or improved land and consumer assets. Commercial loans are expected to be repaid from cash flow from the operations of businesses that have taken out the loans. There are no significant concentrations of loans to any one industry or customer. The ability of customers to repay their loans is generally dependent on the real estate market and general economic conditions prevailing in Colorado, among other factors. 

 

(a)Basis of Presentation

 

The accounting and reporting policies of the Company conform to generally accepted accounting principles in the United States of America and prevailing practices within the financial services industry. All material intercompany balances and transactions have been eliminated in consolidation. The Company’s financial statements reflect all adjustments that are, in the opinion of management, necessary for a fair presentation of its financial position and results of operations for the periods presented. All such adjustments are of a normal and recurring nature. Subsequent events have been evaluated through the date of financial statements issuance.

 

Certain information and note disclosures normally included in consolidated financial statements prepared in accordance with generally accepted accounting principles in the United States of America have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). The interim operating results presented in these financial statements are not necessarily indicative of operating results for the full year. For further information, refer to the consolidated financial statements and notes included in the Company’s Annual Report on Form 10-K, for the year ended December 31, 2013.

 

(b)Use of Estimates

 

The preparation of the consolidated financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the dates of the consolidated balance sheets and income and expense for the periods presented. Actual results could differ significantly from those estimates. Material estimates that are particularly susceptible to significant changes include the assessment for impairment of certain investment securities, the allowance for loan losses and other real estate owned (“OREO”). Assumptions and factors used in these estimates are evaluated on an annual basis and whenever events or changes in circumstances indicate that the previous assumptions and factors have changed. The results of such an evaluation could result in material adjustments to the Company’s estimates.

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(c)Loans and Loan Commitments

 

The Company extends commercial, real estate, agricultural and consumer loans to customers. A substantial portion of the loan portfolio consists of commercial and real estate loans throughout the Front Range of Colorado. The ability of the Company’s borrowers to honor their contracts is generally dependent upon the real estate and general economic conditions prevailing in Colorado, among other factors.

 

Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at their outstanding unpaid principal balances, adjusted for charge-offs, the allowance for loan losses and any deferred fees or costs. Accounting for loans is performed consistently across all portfolio segments and classes.

 

A portfolio segment is defined in accounting guidance as the level at which an entity develops and documents a systematic methodology to determine its allowance for loan losses. A class is defined in accounting guidance as a group of loans having similar initial measurement attributes, risk characteristics and methods for monitoring and assessing risk.

 

Interest income is accrued on the unpaid principal balance of the Company’s loans. Loan origination fees, net of direct origination costs, are deferred and recognized as an adjustment to the related loan yield using the effective interest method without anticipating prepayments.

 

The accrual of interest on loans is discontinued (and the loan is put on nonaccrual status) at the time the loan is 90 days past due unless the loan is well secured and in process of collection. The time at which a loan enters past due status is based on the contractual terms of the loan. In all cases, loans are placed on nonaccrual or charged-off prior to the date on which they would otherwise enter past due status if collection of principal or interest is considered doubtful. The interest on a nonaccrual loan is accounted for using the cash-basis method until the loan qualifies for a return to the accrual basis method, and any payments received on a nonaccrual loan are applied first to the principal balance of the loan. A loan is returned to accrual status after the delinquent borrower’s financial condition has improved, when all the principal and interest amounts contractually due are brought current and when the likelihood of the borrower making future timely payments are reasonably assured.

 

Financial instruments include off‑balance sheet credit instruments, such as commitments to make loans and commercial letters of credit issued to meet customer financing needs. The face amount of each item represents our total exposure to loss with respect to the item, before considering customer collateral or ability to repay. Such financial instruments are recorded when they are funded.

 

(d)Allowance for Loan Losses and Allowance for Unfunded Commitments

The allowance for loan losses or “the allowance” is a valuation allowance for probable incurred loan losses and is reported as a reduction of outstanding loan balances.

 

Management evaluates the amount of the allowance on a regular basis based upon its periodic review of the collectability of the Company’s loans. Factors affecting the collectability of the loans include historical loss experience, the nature and volume of the loan portfolio, adverse situations that may affect borrowers’ ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. Management maintains the allowance at a level that it deems appropriate to adequately provide for known and inherent risks in the loan portfolio and other extensions of credit. The Company’s methodology for estimating the allowance is consistent across all portfolio segments and classes of loans.

 

Loans deemed to be uncollectible are charged off and deducted from the allowance. The Company’s loan portfolio primarily consists of non-homogeneous commercial and real estate loans where charge-offs are considered on a loan-by-loan basis based on the facts and circumstances, including management’s evaluation of collateral values in comparison to book values on real estate-dependent loans. Charge-offs on smaller balance unsecured homogenous type loans such as overdrafts and ready reserves are recognized by the time

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the loan in question is 90 days past due. The provision for loan losses and recoveries on loans previously charged-off are added to the allowance.

 

The allowance consists of both specific and general components. The specific component relates to loans that are individually classified as impaired. All loans are subject to individual impairment evaluation should the pertinent facts and circumstances suggest that such an evaluation is necessary. Factors considered by management in determining impairment include the loan’s payment status and the probability of collecting scheduled principal and interest payments when they become due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the original underlying loan agreement. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. If a loan is impaired, a portion, if any, of the allowance is allocated so that the loan is reported at the present value of estimated future cash flows using the loan’s original contractual rate or at the fair value of collateral, less estimated selling costs, if repayment is expected solely from collateral.

 

The general component of the allowance covers all other loans not specifically identified as impaired and is determined by calculating losses recognized by portfolio segment during the current credit cycle and adjusted based on management’s evaluation of various qualitative factors. In performing this calculation, loans are aggregated into one of three portfolio segments: Real Estate, Consumer and Commercial & Other. An assessment of risks impacting loans in each of these portfolio segments is performed and qualitative adjustment factors, which adjust the historical loss rate, are estimated. These qualitative adjustment factors consider current conditions relative to conditions present throughout the current credit cycle in the following areas: credit quality, loan class concentration levels, economic conditions, loan growth dynamics and organizational conditions. The historical loss experience is adjusted for management’s estimate of the impact of these factors based on the risks present for each portfolio segment.

 

The Company recognizes a liability in relation to unfunded commitments that is intended to represent the estimated future losses on the commitments. In calculating the amount of this liability, management considers the amount of the Company’s off-balance sheet commitments, estimated utilization factors and loan specific risk factors. The Company’s liability for unfunded commitments is calculated quarterly and is included under “other liabilities” in the consolidated balance sheet.

 

(e)Other Real Estate Owned and Foreclosed Assets

 

Assets acquired through or in lieu of loan foreclosure are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. If the asset’s fair value declines subsequent to the assets’ acquisition, a valuation allowance is recorded through expense. Operating revenues and expenses of these assets and reductions in the fair value of the assets are included in noninterest expense. Gains and losses on their disposition are also included in noninterest expense.

 

(f)Other Intangible Assets

 

Intangible assets acquired in a business combination are amortized over their estimated useful lives to their estimated residual values and evaluated for impairment whenever changes in circumstances indicate that such an evaluation is necessary.

 

Core deposit intangible assets (“CDI assets”) are recognized at the time of their acquisition based on valuations prepared by independent third parties or other estimates of fair value. In preparing such valuations, management considers variables such as deposit servicing costs, attrition rates, and market discount rates. CDI assets are amortized to expense over their useful lives, ranging from seven years to 15 years.

 

Customer relationship intangible assets are recognized at the time of their acquisition based upon management’s estimate of their fair value. In preparing such valuations, management considers variables such as growth in existing customer base, attrition rates and market discount rates. The customer relationship

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intangible asset is amortized to expense over its useful life, which has been estimated at ten years and was initially recognized as a result of the acquisition of PCM on July 31, 2012.

 

(g)  Impairment of Long-Lived Assets

Long-lived assets, such as premises and equipment, and finite-lived intangible assets subject to amortization, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. The recoverability of assets to be held and used is measured by a comparison of the carrying value of the asset to the estimated undiscounted future cash flows expected to be generated by the asset. If the carrying value of an asset exceeds its estimated undiscounted future cash flows, an impairment charge is recognized by the amount by which the carrying value of the asset exceeds the fair value of the asset, less costs to sell.

 

Assets to be disposed of are reported at the lower of their carrying value or fair value less costs to sell, and are no longer depreciated. In 2012, the Company recorded an impairment related to two bank buildings that were later transferred to assets held for sale. At March 31, 2014, one of these properties remained held for sale and is included in “other assets” in the consolidated balance sheet.

 

(h) Derivative Instruments

The Company records all derivatives on its consolidated balance sheets at fair value. At the inception of a derivative contract, the Company designates the derivative as one of three types based on the Company’s intentions and belief as to the derivative’s likely effectiveness as a hedge. These three types are (1) a hedge of the fair value of a recognized asset or liability or of an unrecognized firm commitment (“fair value hedge”), (2) a hedge of a forecasted transaction or the variability of cash flows to be received or paid related to a recognized asset or liability (“cash flow hedge”), or (3) an instrument with no hedging designation (“stand-alone derivative”). To date, the Company has entered into cash flow hedges and stand-alone derivative agreements but has not entered into any fair value hedges. For a cash flow hedge, the gain or loss on the derivative is reported in other comprehensive income and is reclassified into earnings in the same periods during which the hedged transaction affects earnings. Any portion of the cash flow hedge not deemed highly effective in hedging the changes in expected cash flows of the hedged item are recognized immediately in current earnings. Changes in the fair value of derivatives that do not qualify for hedge accounting are reported currently in earnings, as noninterest income.

 

The Company formally documents the relationship between derivatives and hedged items, as well as the risk-management objective and the strategy for undertaking hedge transactions, at the inception of the derivative contract. This documentation includes linking cash flow hedges to specific assets and liabilities on the balance sheet or to specific firm commitments or forecasted transactions. The Company also formally assesses, both at the hedge’s inception and on an ongoing basis, whether the hedge is highly effective in offsetting changes in cash flows of the hedged items.

 

(i)Stock Incentive Plan

 

The Company’s Amended and Restated 2005 Stock Incentive Plan (the “Incentive Plan”) provides for the grant of stock options, stock awards, stock units awards, performance stock awards, stock appreciation rights, and other equity-based awards representing up to a total of 1,700,000 shares of voting common stock to key employees, nonemployee directors, consultants and prospective employees. As of March 31, 2014, the Company had only granted stock awards. The Company recognizes stock compensation expense for services received in a share-based payment transaction over the required service period, generally defined as the vesting period. For awards with graded vesting, compensation cost is recognized on a straight-line basis over the requisite service period for the entire award. The compensation cost of employee and director services received in exchange for stock awards is based on the grant date fair value of the award, as determined by quoted market prices. Stock compensation expense recognized considers estimated forfeitures and is adjusted as necessary to reflect actual forfeitures. The Company has issued stock awards that vest based on the passage of time over service periods of one to five years (in some cases vesting in annual installments, in other cases cliff vesting at the end of the service period), and other stock awards that vest contingent upon the satisfaction of certain performance conditions. The last date on which outstanding performance stock awards may vest is

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December 31, 2018. At March 31, 2014, certain performance stock awards were expected to vest prior to their expiration, while 70,571 shares were not expected to vest prior to their expiration, based on current projections in comparison to performance conditions. Should these expectations change, additional expense could be recorded or reversed in future periods.

 

(j)    Stock Repurchase Plan

 

On April 3, 2014, the Company announced that its Board of Directors had authorized the repurchase of up to 1,000,000 shares of its voting common stock, par value $0.001 per share. Repurchases under the program may commence immediately and continue through April 2, 2015.

 

(k)    Income Taxes

 

Income tax expense is the total of the current year’s income tax payable or refundable and the increase or decrease in deferred tax assets and liabilities. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period of the enactment date.

 

Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that the Company will not realize some portion of, or the entire deferred tax asset. In assessing the Company’s likelihood of realizing deferred tax assets, management evaluates both positive and negative evidence, including the existence of any cumulative losses in the current year and the prior two years, the amount of taxes paid in available carry-back years, forecasts of future income, taking into account applicable tax planning strategies, and assessments of current and future economic and business conditions. Management performs this analysis quarterly and adjusts as necessary. At March 31, 2014 and December 31, 2013, the Company had a net deferred tax asset of $13,364,000 and $16,681,000, respectively, which includes the deferred tax asset associated with the unrealized loss on securities. After analyzing the composition of and changes in the deferred tax assets and liabilities and considering the Company’s forecasted future taxable income and various tax planning strategies, including the intent to hold the securities available for sale that were in a loss position until maturity, management determined that as of March 31, 2014 it was “more likely than not” that the net deferred tax asset would be fully realized. As a result, there was no valuation allowance with respect to the Company’s deferred tax asset as of March 31, 2014 or December 31, 2013.

 

At March 31, 2014 and December 31, 2013, the Company did not have any uncertain tax positions for which a tax benefit was disallowed under current accounting guidance. A tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely to be realized on examination. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded.

 

The Company and the Bank are subject to U.S. federal income tax and State of Colorado income tax. The Company is no longer subject to examination by Federal or State taxing authorities for years before 2010 except to the extent of the amount of the 2010 carryback claim for a refund filed in 2011 with respect to 2008. At March 31, 2014 and December 31, 2013, the Company did not have any unrecognized tax benefits. The Company does not expect the amount of any unrecognized tax benefits to materially change in the next 12 months. The Company recognizes interest related to income tax matters as interest expense and penalties related to income tax matters as other noninterest expense. At March 31, 2014 and December 31, 2013, the Company did not have any amounts accrued for interest or penalties.

 

(l)Earnings per Common Share

 

Basic earnings per common share represents the earnings allocable to common stockholders divided by the weighted average number of common shares outstanding during the period. When there is a loss, generally there is no difference between basic and diluted loss per common shares as any potential additional common shares are typically anti-dilutive as they decrease the loss per common share. Dilutive common shares that may be issued by the Company represent unvested stock awards subject to a service or performance condition.

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Earnings per common share have been computed based on the following calculation of weighted average shares outstanding:

 

(1)Share amounts have been adjusted to reflect the Company's 1-for-5 reverse stock split on May 20, 2013.

(2)The impact of unvested stock grants representing 745,406 shares at March 31, 2014 had a dilutive impact of 92,427 shares in the diluted earnings per share calculation for the three months ended March 31, 2014. The impact of unvested stock grants representing 527,684 shares at March 31, 2013 had a dilutive impact of 73,309 shares in the diluted earnings per share calculation for the three months ended March 31, 2013.

 

(m)    Recently Issued Accounting Standards

 

Adoption of New Accounting Standards:

 

In July of 2013 the FASB issued an accounting standards update to reduce the diversity in the accounting practice with respect to the presentation of unrecognized tax benefits when net operating loss or credit carryforwards are present. The provisions of this update require the separate presentation of unrecognized tax benefits related to net operating loss carryforwards and credit carryforwards apart from other deferred tax assets. For the Company, the amendments of the update became effective for fiscal years, and interim periods within those years, beginning subsequent to December 15, 2013. At March 31, 2014, the impact of this update on the Company’s disclosures was not material.

 

 (n)  Reclassifications

 

Certain reclassifications of prior year balances have been made to conform to the current year presentation. These reclassifications had no impact on the Company’s consolidated financial position, results of operations or net change in cash and cash equivalents. Share and per share amounts have been adjusted to reflect the Company’s 1-for-5 reverse stock split on May 20, 2013.  

 

 

(2)Securities

 

The fair value of available for sale debt securities and the related gross unrealized gains and losses recognized in accumulated other comprehensive income (loss) (“AOCI”)  were as follows at the dates presented:

 

 

 

 

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The carrying amount, unrecognized gains/losses and fair value of securities held to maturity were as follows at the dates presented:

 

 

 

 

The proceeds from sales and calls of securities and the associated gains are listed below:

 

 

 

 

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The amortized cost and estimated fair value of available for sale debt securities by contractual maturity at March 31, 2014 are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to prepay obligations with or without prepayment penalties. Securities not due at a single maturity date are presented separately.

 

 

 

 

 

 

 

 

The following tables present the fair value and the unrealized loss on securities that were temporarily impaired as of March 31, 2014 and December 31, 2013, aggregated by major security type and length of time in a continuous unrealized loss position:

 

 

 

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In determining whether or not there is an other-than-temporary-impairment (“OTTI”) for a security, management considers many factors, including: (1) the length of time for which and the extent to which the security’s fair value has been less than cost, (2) the financial condition and near-term prospects of the security’s issuer, (3) whether the decline in the security’s value was affected by macroeconomic conditions, and (4) whether the Company intends to sell the security and whether it is more likely than not that the Company will be required to sell the security before recovering its fair value. The assessment of whether an OTTI exists involves a high degree of subjectivity and judgment and is based on the information available to management at a particular point in time.

The Company did not recognize any OTTI during the quarter ended March 31, 2014 or March 31, 2013. There are no accumulated credit losses on any of the Company’s securities as of March 31, 2014.

 

 

At March 31, 2014, there were 130 individual securities in an unrealized loss position, including 43 individual securities that had been in a continuous unrealized loss position for 12 months or longer. Management has evaluated these securities in addition to the remaining 87 securities in an unrealized loss position and has determined that the decline in value since their purchase dates was primarily attributable to changes in market interest rates. Likewise, management determined that the increase in securities in an unrealized loss position in excess of 12 months between December 31, 2013 and March 31, 2014 was primarily attributable to the timing of interest rate fluctuations. At March 31, 2014, the Company did not intend to sell, and did not consider it likely that it would be required to sell, any of these securities prior to recovery in their fair value.

 

The Company’s unrated and rated municipal bond securities, along with the Company’s other rated investment securities, are subject to an annual internal review process that management has historically performed in the fourth quarter. The review process includes a review of the securities’ issuers’ most recent financial statements, including an evaluation of the expected sufficiency of the issuers’ cash flows relative to their debt service requirements. In addition, management considers any interim information reasonably made available to it that would prompt the need for more frequent review. At March 31, 2014, the Company’s unrated municipal bonds comprised approximately 5.6% of the carrying value of the Company’s entire municipal bond portfolio.

 

At March 31, 2014, a hospital revenue bond with a book value of $24,115,000 accounted for 12.4% of total stockholders’ equity. This amortizing tax-exempt bond was issued by a hospital in the Company’s footprint and is secured by a pledge of revenues and a deed of trust from the hospital, carries an interest rate of 4.75% and matures December 1, 2031. Utilizing the discounted cash flow method and an estimate of current market rates for similar bonds, management determined the estimated fair value of this bond as of March 31, 2014 approximated its par value. Management determined that the estimated fair value of this bond as of December 31, 2013 reflected an unrealized loss of $478,000. In addition to conducting its annual review of unrated municipal bonds, the most recent of which was completed in the fourth quarter 2013, management conducts a quarterly review of the hospital’s financial statements. To date, the bond has paid principal and interest in accordance with its contractual terms. During the fourth quarter 2013 the issuer redeemed $10,810,000 in advance of the contractual repayment schedule.

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(3)Loans

 

A summary of net loans held for investment by loan type at the dates indicated is as follows:

 

 

 

Activity in the allowance for loan losses for the period indicated is as follows:

 

 

 

The Company’s additional disclosures relating to loans and the allowance for loan losses are broken out into two subsets: portfolio segment and class. The portfolio segment level is defined as the level where financing receivables are aggregated in developing the Company’s systematic method for calculating its allowance for loan losses. The class level is the second level at which credit information is presented and represents the categorization of financing related receivables at a slightly less aggregated level than the portfolio segment level. Because data presented according to class is dependent upon the underlying purpose of the loan, whereas loan data organized by portfolio segment is determined by the loan’s underlying collateral, disclosures broken out by portfolio segment versus class may not be in agreement.

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The following tables provide detail for the ending balances in the Company’s allowance for loan losses and loans held for investment, broken down by portfolio segment as of the dates indicated. In addition, the tables also provide a rollforward by portfolio segment of the allowance for loan losses for the three months ended March 31, 2014 and March 31, 2013. The detail provided for the amount of the allowance for loan losses and loans individually versus collectively evaluated for impairment (i.e., the general component versus the specific component of the allowance for loan losses) corresponds to the Company’s systematic methodology for estimating its allowance for loan losses.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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The following tables provide additional detail with respect to impaired loans broken out according to class as of the dates indicated. The recorded investment included in the following table represents customer balances net of any partial charge-offs recognized on the loans, net of any deferred fees and costs.  The unpaid balance represents the recorded balance prior to any partial charge-offs. Interest income recognized year-to-date may exclude an immaterial amount of interest income on matured loans that are 90 days or more past due, but that are in the process of being renewed and thus are still accruing.

 

 

 

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The gross year-to-date interest income that would have been recorded had the nonaccrual loans been current in accordance with their original terms was $199,000 for the three months ended March 31, 2014 and $273,000 for the three months ended March 31, 2013.

 

The following tables summarize by class loans classified as past due in excess of 30 days or more in addition to those loans classified as nonaccrual:

 

 

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The Company categorizes loans into risk categories based on relevant information about the ability of a particular borrower to service its debt, such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. The Company uses the following definitions for risk ratings, which are consistent with the definitions used in supervisory guidance:

 

Substandard.  Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral, if any, pledged to secure the loan. Loans so classified have a well-defined weakness or weaknesses that jeopardize the collection of the debt. They are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected.

 

Doubtful.  Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

 

Loans not meeting the criteria above are considered to be non-classified loans.

 

The following tables provide detail for the risk categories of loans by class of loans based on the most recent credit analysis performed as of the dates indicated: 

 

 

 

 

The book balance of troubled debt restructurings (“TDRs”) at March 31, 2014 and December 31, 2013 was

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$8,530,000 and $9,332,000, respectively. Management has established approximately $74,000 and $335,000 in specific reserves with respect to these loans as of March 31, 2014 and December 31, 2013. As of both March 31, 2014 and December 31, 2013, the Company had no material additional amounts committed on loans classified as TDRs. 

 

During the first quarter 2014, management made six loan modifications with respect to outstanding TDRs. The modifications involved the extension of maturity on six substandard graded loans.  

 

The following tables present loans by class modified as TDRs that occurred during the three months ended March 31, 2014 and March 31, 2013 (in thousands):

   

 

 

 

 

 

 

A loan is considered to be in payment default once it is 90 days contractually past due under the modified terms. There were no defaults on TDRs during the three months ended March 31, 2014. A single default occurred on a TDR during the three months ended March 31, 2013,  a specific reserve of $121,000 was set aside for this loan as of March 31, 2013.

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(4)Other Real Estate Owned

 

Changes in the carrying amount of the Company’s OREO for the three months ended March 31, 2014 and March 31, 2013 were as follows (in thousands):

 

 

 

Expenses related to foreclosed assets include:

 

 

 

 

 

(5)Other Intangible Assets

 

Other intangible assets with finite lives are amortized over their respective estimated useful lives to their estimated residual values. As of March 31, 2014, the Company had intangible assets comprised of its core deposit intangible assets and a  customer relationship intangible asset.

 

The following table presents the gross amounts of core deposit intangible assets and a  customer relationship intangible asset and the related accumulated amortization at the dates indicated: 

 

 

         

Following is the aggregate amortization expense recognized in each period:

 

 

 

 

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(6)Borrowings

 

At March 31, 2014, the Company’s outstanding borrowings were $173,017,000 as compared to $130,000,000 at December 31, 2013. These borrowings at March 31, 2014 consisted of $110,000,000 of term notes and $63,017,000 of advances on our line of credit, both with the Federal Home Loan Bank (the “FHLB”). At December 31, 2013, outstanding borrowings consisted of $110,000,000 of term notes and $20,000,000 of advances on our line of credit, both with the FHLB.

 

The Company has an advance, pledge and security agreement with the FHLB and had pledged qualifying loans and securities in the amount of $392,722,000 at March 31, 2014 and $339,727,000 at December 31, 2013. The maximum credit allowance for future borrowings, including term notes and advances on the line of credit, was $219,705,000 at March 31, 2014 and $209,727,000 at December 31, 2013.  

 

The interest rate on the line of credit varies with the federal funds rate, and was 0.21% at March 31, 2014. The term notes have fixed interest rates that range from 2.52% to 3.17%, with a weighted average rate of 2.97%, and remaining maturities as of March 31, 2014 ranging from 44 to 46 months.

 

(7) Subordinated Debentures and Trust Preferred Securities

 

At both March 31, 2014 and December 31, 2013, the balance of the Company’s outstanding subordinated debentures was $25,774,000 with a weighted average cost of funds of 3.07%. During the first quarter 2013, the Company redeemed the subordinated debentures issued by CenBank Trusts I and II. As a result of the early redemption of these instruments, the Company recognized an aggregate prepayment penalty of $629,000. Prior to their early redemption on March 7, 2013 and February 22, 2013, the CenBank Trusts I and II accrued interest at 10.60% and 10.20%, respectively.

 

The Company’s remaining subordinated debentures were issued in two separate series. Each issuance has a maturity of 30 years from its date of issuance. The subordinated debentures were issued to trusts established by the Company, which in turn issued $25,000,000 of trust preferred securities (TruPS”). Generally, and with certain limitations, the Company is permitted to call the debentures subsequent to the first five or ten years, as applicable, after issuance, if certain conditions are met, or at any time upon the occurrence and continuation of certain changes in either the tax treatment or the capital treatment of the trusts, the debentures or the preferred securities. The Guaranty Capital Trust III TruPS became callable at each quarterly interest payment date starting on July 7, 2008. The CenBank Trust III TruPS became callable at each quarterly interest payment date starting on April 15, 2009.

 

As of March 31, 2014, the Company was in compliance with all financial covenants of these remaining subordinated debentures.

 

At March 31, 2014 the Company had accrued, unpaid interest on its subordinated debentures of approximately $198,000 compared to $202,000 at December 31, 2013. Interest payable on subordinated debentures is included in interest payable and other liabilities on the consolidated balance sheets.

 

The Company is not considered the primary beneficiary of the trusts that issued the TruPS (variable interest entities); therefore, the trusts are not consolidated in the Company’s financial statements and the subordinated debentures are shown as liabilities. The Company’s investment in the common stock of each trust is included in other assets in the Company’s consolidated balance sheets.

 

Although the securities issued by each of the trusts are not included as a component of stockholders’ equity in the consolidated balance sheets, they are treated as capital for regulatory purposes. Specifically, under applicable regulatory guidelines, the $25,000,000 of TruPS issued by the trusts qualify as Tier 1 capital, up to a maximum of 25% of capital on an aggregate basis. Any amount that exceeds 25% qualifies as Tier 2 capital. At March 31, 2014, the full $25,000,000 of the TruPS qualified as Tier 1 capital.

 

Under the Dodd-Frank Act and a recent joint rule from the Federal Reserve Board, the Office of the Comptroller of Currency, and the FDIC, certain TruPS are no longer eligible to be included as Tier 1 capital for regulatory purposes. However, an exception to this statutory prohibition applies to securities issued prior to May 19, 2010 by bank holding companies with less than $15 billion of total assets. As we have less than $15 billion in total

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assets and issued all of our TruPS prior to May 19, 2010, we expect that our TruPS will continue to be eligible to be treated as Tier 1 capital, subject to other rules and limitations.

 

The following table summarizes the terms of each outstanding subordinated debenture issuance at March 31, 2014 (dollars in thousands):

*  Call date represents the earliest or next date the Company can call the debentures

** On April 7, 2014, the rate on the Guaranty Capital Trust III subordinated debentures reset to 3.33%.  On April 15, 2014, the rate on the CenBank Trust III subordinated debentures reset to 2.88%. 

 

(8)Commitments 

 

The Bank enters into credit-related financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, standby letters of credit and commercial letters of credit. Such commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets.

 

The Bank’s exposure to credit loss is represented by the contractual amount of these commitments. The Bank follows the same credit policies in making commitments as it does for on-balance sheet instruments.

 

At the dates indicated, the following financial instruments were outstanding whose contract amounts represented credit risk:

 

 

At March 31, 2014, the rates on the fixed rate commitments to extend credit ranged from 2.40% to 7.25%.

 

A commitment to extend credit is an agreement to lend to a customer as long as there is no violation of any condition established in the underlying contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Several of the commitments may expire without being drawn upon. Therefore, the total commitment amounts do not necessarily represent future cash requirements. Off-balance sheet risk to credit loss exists up to the face amount of these instruments, although material losses are not anticipated. The same credit policies used for loans are used to make such commitments, including obtaining collateral, if necessary, at exercise of the commitment.

 

A commitment to extend credit under an overdraft protection agreement is a commitment for a  possible future extension of credit to an existing deposit customer. These lines of credit are uncollateralized and usually do not contain a specified maturity date and may not be drawn upon to the total extent to which the Bank is committed.

 

Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. These letters of credit are primarily issued to support public and private borrowing arrangements. A majority of letters of credit issued have expiration dates within one year. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Bank generally holds collateral supporting those commitments if deemed necessary.

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(9)Fair Value Measurements and Fair Value of Financial Instruments

 

Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. There are three levels of inputs that may be used to measure fair values:

 

Level 1 - Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets.

 

Level 2 - Significant other observable inputs other than Level 1 prices such as quoted prices in markets that are not active, quoted prices for similar assets, or other inputs that are observable, either directly or indirectly, for substantially the full term of the asset.

 

Level 3 - Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

 

A financial instrument’s level within the fair value hierarchy is based on the lowest level of input that is significant to the instrument’s fair value measurement. Transfers of financial instruments between levels within the fair value hierarchy are recognized on the date management determines that the underlying circumstances or assumptions have changed.

 

The fair values of securities available for sale are generally determined by matrix pricing, which is a mathematical technique widely used in the financial industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities (Level 2 inputs). For securities where market values of similar securities are not available management utilizes a discounted cash flow model with market-adjusted discount rates or other unobservable inputs to estimate fair value. Due to the lack of ratings available on these securities, management determined that a relationship to other benchmark quoted securities was unobservable and as a result these securities should be classified as Level 3 (Level 3 inputs). The valuation of the Company’s Level 3 bonds is highly sensitive to changes in unobservable inputs.

 

Currently, the Company uses interest rate swaps to manage interest rate risk. The fair value of each interest rate swap is determined using the market standard methodology of netting the discounted future fixed cash payments (or receipts) and the discounted expected variable cash receipts (or payments). The variable cash receipts (or payments) are based on the expectation of future interest rates (forward curves) derived from observed market interest rate curves (Level 2 inputs). The Company considers the value of the swap to be highly sensitive to fluctuations in interest rates.

 

Upon being designated impaired, impaired loans are evaluated to determine whether or not they are collateral-dependent. Collateral-dependent impaired loans are generally carried at the lower of cost or fair value of the collateral, less estimated selling costs. Collateral values are determined based on appraisals performed by qualified licensed appraisers hired by the Company and then further adjusted if warranted based on relevant facts and circumstances. The appraisals may utilize a single valuation approach or a combination of approaches including the comparable sales and income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are typically significant and result in a Level 3 classification of the inputs for determining fair value. Impaired loans are reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly, based on the same factors identified above. Because of the high degree of judgment required in estimating the fair value of collateral underlying impaired loans and because of the relationship between fair value and general economic conditions, management considers the fair value of impaired loans to be highly sensitive to changes in market conditions.

 

OREO is valued at the time the related loan is foreclosed upon and the asset is transferred to OREO. The value is based primarily on third party appraisals, less estimated selling costs. The appraised value may be adjusted if warranted based on relevant facts and circumstances. The appraisals may utilize a single valuation approach or a combination of approaches including the comparable sales and income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are typically significant and result in a Level 3 classification of the inputs for determining fair value. OREO is reviewed and evaluated on at least an annual basis for additional impairment and

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adjusted accordingly, based on the same factors identified above. Because of the high degree of judgment required in estimating the fair value of OREO properties and because of the relationship between fair value and general economic conditions management considers the fair value of OREO to be highly sensitive to changes in market conditions.

 

Financial Assets and Liabilities Measured on a Recurring Basis

 

Assets and liabilities measured at fair value on a recurring basis are summarized below:

 

 

There were no transfers of financial assets and liabilities among Level 1, Level 2 and Level 3 during the three months ended March 31, 2014.  

 

The table below presents a reconciliation and income statement classification of gains and losses for all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three months ended March 31, 2014 and March 31, 2013:  

 

 

 

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For the three months ended March 31, 2014 and March 31, 2013, the entire amount of other comprehensive income for assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) consisted of changes in unrealized gains and losses on the mark-to-market of securities designated as available for sale.

 

The following tables present quantitative information about Level 3 fair value measurements on the Company’s state and municipal securities at March 31, 2014 and December 31, 2013:

 

 

 

 

 

 

* The Company relies on a third-party pricing service to value non-rated municipal securities. Because of the lack of credit ratings, management considers the relationship between rates on these securities and benchmarks rates to be unobservable. The unobservable adjustments used by the third-party pricing service were not readily available.

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Financial Assets and Liabilities Measured on a Nonrecurring Basis

 

The following tables present impaired loans measured at fair value on a non-recurring basis as of March 31, 2014 and December 31, 2013. The valuation methodology used to measure the fair value of these loans is described earlier in this Note.

 

 

 

 

Impaired loans, which are measured for impairment using either the fair value of collateral or the present value of expected future cash flows, had a carrying amount of $20,362,000 at March 31, 2014, after a partial charge-off of $1,541,000. In addition, these loans have a specific valuation allowance of $104,000 at March 31, 2014. Of the $20,362,000 impaired loan portfolio at March 31, 2014,  $191,000 were carried at fair value as a result of the aforementioned charge-offs and specific valuation allowances. The remaining $20,171,000 of impaired loans were not carried at fair value at March 31, 2014,  because these loans did not require a specific reserve calculated based on the fair value of collateral or have amounts previously charged-off. During the three months ended March 31, 2014,  the single charge-off of a loan impaired as of December 31, 2013 accounted for the majority of the reduction in the specific valuation allowance on impaired loans during the first quarter 2014.

 

Impaired loans had a carrying amount of $21,703,000 at December 31, 2013, after a partial charge-off of $1,507,000. In addition, these loans had a specific valuation allowance of $565,000 at December 31, 2013.  Of the $21,703,000 impaired loan portfolio at December 31, 2013,  $425,000 were carried at fair value as a result of the aforementioned charge-offs and specific valuation allowances. The remaining $21,278,000 of impaired loans were not carried at fair value at December 31, 2013,  because these loans did not require a specific reserve calculated based on the fair value of collateral or have amounts previously charged-off.

 

Impaired loans are reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted accordingly, based on the same factors identified above.

 

The following tables present quantitative information about Level 3 fair value measurements for impaired loans measured at fair value on a non-recurring basis as of March 31, 2014 and December 31, 2013.

 

 

 

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Nonfinancial Assets and Liabilities Measured on a Nonrecurring Basis

 

Nonfinancial assets and liabilities measured at fair value on a nonrecurring basis are summarized below:

 

 

 

OREO had a carrying amount of $4,419,000 at March 31, 2014, which is made up of an outstanding balance of $5,441,000, with a valuation allowance of $1,022,000. OREO write-downs and sales had no impact on the OREO valuation during the first quarter 2014.  Because there were no additions to our OREO properties nor any valuation adjustments on these properties during the first quarter 2014 none of our OREO properties were carried at fair value as of March 31, 2014.

 

OREO had a carrying amount of $4,493,000 at December 31, 2013, which was made up of an outstanding balance of $5,515,000, with a valuation allowance of $1,022,000. 

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The following table presents quantitative information about Level 3 fair value measurements for OREO measured at fair value on a non-recurring basis as of December 31, 2013:

 

 

 

 

Fair Value of Financial Instruments

 

The estimated fair values, and related carrying amounts, of the Company’s financial instruments are as follows:

 

 

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The fair value of a financial instrument is the current amount that would be exchanged between willing parties, other than in a forced liquidation. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Company’s various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument.

 

Certain financial instruments and all nonfinancial instruments are excluded from the disclosure requirements. Therefore, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Company.

 

The following methods and assumptions are used by the Company in estimating fair value disclosures for financial instruments:

 

 

The carrying amounts of cash and short-term instruments approximate fair values (Level 1).

 

 

Fair values for securities available for sale and held to maturity are generally determined by matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities (Level 2). For positions that are not traded in active markets or are subject to transfer restrictions (i.e., bonds valued with Level 3 inputs), management uses a combination of reviews of the underlying financial statements, appraisals and management’s judgment regarding credit quality and intent to sell in order to determine the value of the bond.

 

It is not practical to determine the fair value of bank stocks due to restrictions placed on the transferability of FHLB stock, Federal Reserve Bank stock and Bankers’ Bank of the West stock. These three stocks comprise the majority of the balance of the Company’s bank stocks.

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(c) Loans Held for Investment

 

For variable rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values (Level 3). Fair values for other loans (e.g., commercial real estate and investment property mortgage loans, commercial loans) are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality (Level 3). Impaired loans are valued at the lower of cost or fair value as described above in this note. The methods utilized to estimate the fair value of loans do not necessarily represent an exit price.

 

(d) Loans Held for Sale

 

Loans held for sale are carried at the lower of cost or fair value, with fair value determined by the sales price agreed upon in negotiation with the purchaser (Level 1).

 

(e) Deposits

 

The fair values of demand deposits (e.g., interest and non-interest checking, passbook savings, and certain types of money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amount) (Level 2). The carrying amounts of variable rate, fixed-term money market accounts and certificates of deposit approximate their fair values at the reporting date (Level 2). Fair values for fixed rate certificates of deposit are estimated using a discounted cash flows calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits (Level 2).

 

(f) Short-term Borrowings

 

The carrying amounts of federal funds purchased, borrowings under repurchase agreements, and other short-term borrowings maturing within ninety days approximate their fair values (Level 2).

 

(g) Long-term Borrowings

 

The fair values of the Company’s long-term borrowings are estimated using discounted cash flow analyses based on the Company’s current incremental borrowing rates for similar types of borrowing arrangements (Level 2).

 

(h) Subordinated Debentures

 

The fair values of the Company’s Subordinated Debentures are estimated using discounted cash flow analyses based on the Company’s current incremental borrowing rates for similar types of borrowing arrangements (Level 3).

 

(i) Accrued Interest Receivable/Payable

 

The carrying amounts of accrued interest approximate fair value (Level 2).

 

(j) Interest Rate Swaps, net

 

The fair value of interest rate swaps are determined using the market standard methodology of netting the discounted future fixed cash payments (or receipts) and the discounted expected variable cash receipts (or payments). The variable cash receipts (or payments) are based on the expectation of future interest rates (forward curves) derived from observed market interest rate curves (Level 2).

 

(k) Off-balance Sheet Instruments

 

Fair values for off-balance sheet, credit-related financial instruments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing. The fair value of commitments is not material.

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(10) Derivatives and Hedging Activities

 

The Company is exposed to certain risks arising from both its business operations and economic conditions. The Company principally manages its exposures to a wide variety of business and operational risks through management of its core business activities. The Company utilizes derivative financial instruments to assist in the management of interest rate risk, primarily helping to secure long term borrowing rates. Specifically, the Company enters into derivative financial instruments to manage exposures that arise from business activities that result in the payment or receipt of future known and uncertain cash amounts, the value of which are determined by interest rates. The Company’s derivative financial instruments are used to manage differences in the amount, timing, and duration of the Company’s known or expected cash payments or receipts principally related to certain variable-rate borrowings. The Company does not use derivatives for trading or speculative purposes.

 

The table below presents the fair value of the Company’s derivative financial instruments as well as their classification on the consolidated balance sheet as of March 31, 2014 and December 31, 2013.

 

 

 

The Company’s objectives in using interest rate derivatives are to add stability and predictability to interest expense and to manage the Company’s exposure to interest rate movements. To accomplish this objective, the Company primarily uses interest rate swaps as part of its interest rate risk management strategy. For hedges of the Company’s variable-rate borrowings, interest rate swaps designated as cash flow hedges involve the receipt of variable amounts from a counterparty in exchange for the Company making fixed payments. As of March 31, 2014, the Company had two interest rate swaps with an aggregate notional amount of $50,000,000 that were designated as a cash flow hedge associated with the Company’s forecasted variable-rate borrowings.  The swaps are forward-starting with the first $25,000,000 swap becoming effective in June 2015 and the second swap becoming effective in March 2016.

 

The effective portion of changes in the fair value of derivatives designated and that qualify as cash flow hedges is recorded in AOCI and is subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings. The ineffective portion of the change in fair value of the derivatives is recognized directly in earnings. The Company’s cash flow hedges are used to hedge the forecasted variable cash outflows associated with forecasted issuances of FHLB advances. During the three months ended March 31, 2014, the income statement effect of hedge ineffectiveness was not material.

 

Amounts reported in AOCI related to derivatives will be reclassified to interest expense as interest payments are made on the Company’s variable-rate liabilities. Management expects that, during the next 12 months, no amounts will be reclassified as an adjustment to interest expense related to interest rate swaps as the related borrowings which correspond to the hedge are anticipated to commence in June of 2015.

 

The Company executes interest rate swaps with commercial banking customers to facilitate their respective risk management strategies. Those interest rate swaps are simultaneously hedged by offsetting interest rate swaps that the Company executes with another third party, such that the Company minimizes its net risk exposure resulting from such transactions. As the interest rate swaps associated with this program do not meet the strict hedge accounting requirements, changes in the fair value of both the customer swaps and the offsetting swaps are recognized directly in earnings. The impact of these customer interest rate swaps on the company’s financial statements was not material for any periods covered by this report.

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The table below presents the effect of the Company’s derivative financial instruments on both comprehensive income and net income for the three months ended March 31, 2014 and March 31, 2013:

 

 

 

 

The Company has agreements with its derivative counterparties that contain a cross-default provision whereby if the Company defaults on any of its indebtedness, including default where repayment of the indebtedness has not been accelerated by the lender, then the Company could also be declared in default on its derivative obligations.

 

The Company has minimum collateral posting thresholds with certain of its derivative counterparties, and has posted $1,083,000 against its obligations under these agreements. If the Company had breached any of these provisions at March 31, 2014, it could have been required to settle its obligations under the agreements at the termination value.  

 

(11) Stock-Based Compensation

 

Under the Company’s Incentive Plan, the Company’s Board of Directors may grant stock-based compensation awards to nonemployee directors, key employees, consultants and prospective employees under the terms described in the Incentive Plan. Stock-based compensation awards issuable under the Incentive Plan include the grant of options, restricted stock awards, restricted stock unit awards, performance stock awards, stock appreciation rights and other equity based awards. The Incentive Plan provides that eligible participants may be granted shares of Company common stock that are subject to forfeiture until the grantee vests in the stock award based on the established conditions, which may include service conditions, established performance measures or both.

 

Prior to the vesting of stock awards that are subject to a service vesting condition, each grantee has the rights of a stockholder with respect to voting the shares of stock represented by the award. The grantee is not entitled to dividend rights with respect to the shares of stock until vesting occurs. Prior to vesting of the stock awards with performance vesting conditions, each grantee has the rights of a stockholder with respect to voting of the shares of stock represented by the award. The recipient is generally not entitled to dividend rights with respect to unvested shares. Other than the stock awards with service and performance based vesting conditions, no other grants have been made under the Incentive Plan.

 

The Incentive Plan authorizes grants of stock-based compensation awards of up to a total of 1,700,000 shares of Company voting common stock, subject to adjustments upon the occurrence of certain events. As of March 31, 2014 and December 31, 2013, there were outstanding awards representing 745,406 and 386,525 shares of unvested stock (net of forfeitures), with 526,624 and 931,384 shares remaining available for grant under the Incentive Plan, respectively.

 

Of the 745,406 shares represented by unvested awards at March 31, 2014, approximately 674,835 shares are expected to vest. At March 31, 2014, there were 326,560 shares of restricted stock outstanding that were subject to a performance condition. Management expects that 255,989 of these 326,560 shares will vest and that the remaining shares will expire unvested. The performance shares that are expected to vest relate to awards granted to various key employees from February 2013 through March 2014. The vesting of these performance shares is contingent upon the meeting of certain return on asset performance measures. The performance-based shares awarded in 2012, 2013 and 2014 each include a “threshold” and “target” performance level, with vesting determined based on where actual performance falls in relation to the numeric range represented by these performance criteria. Management expects that the targeted performance goals will be met with respect to the performance-based shares awarded in 2013 and

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2014 and does not expect to reach the threshold performance criteria for the performance awards granted in 2012, which is consistent with the level of expense currently being recognized over the vesting period. Should this expectation change, additional compensation expense could be recorded in future periods or previously recognized expense could be reversed.

 

A summary of the status of unearned stock awards and the change during the period is presented in the table below:

 

 

 

The Company recognized $459,000 and $337,000 in stock-based compensation expense for services rendered for the three months ended March 31, 2014 and March 31, 2013, respectively. The total income tax benefit recognized for share-based compensation arrangements was $174,000 and $128,000 for the three months ended March 31, 2014 and March 31, 2013, respectively. At March 31, 2014, compensation cost of $6,395,000 related to unvested awards not yet recognized is expected to be recognized over a weighted-average period of 2.6 years. The fair value of awards that vested in the three months ended March 31, 2014 was approximately $604,000.

 

(12)   Capital Ratios

 

The following table provides the capital ratios of the Company and Bank as of the dates presented, along with the applicable regulatory capital requirements:

 

 

 

 

 

(

 

(13)  Legal Contingencies  

 

The Company and the Bank are defendants, from time to time, in legal actions at various points of the legal process, including appeals, arising from transactions conducted in the ordinary course of business. Management believes, after consultations with legal counsel that it is not probable that the outcome of current legal actions will result in a liability that has a material adverse effect on the Company’s consolidated financial position, results of operations, comprehensive income or cash flows. In the event that such legal action results in an unfavorable outcome, the resulting liability could have a material adverse effect on the Company’s consolidated financial position, results of operations, comprehensive income or cash flows.